The Secret World of Jim Simons

How does this prize-winning mathematician and former code breaker rack up his astonishing returns?

How does this prize-winning mathematician and former code
breaker rack up his astonishing returns?

By Hal Lux
November 2000
Institutional Investor Magazine

How does this prize-winning mathematician and former code
breaker rack up his astonishing returns? Try a little luck--
and a firm full of Ph.D.s.

Last April the State University of New York at Stony Brook held
a gala reception at the Waldorf-Astoria Hotel in midtown
Manhattan to celebrate raising a record $1 million -- a tidy
sum for a state school. After cocktails a balding, white-haired
man rose from his seat on the dais to thank the sellout crowd,
which included such celebrities as Oscar-winning movie director
Martin Scorsese, for its generosity.

Chances are you haven't heard of Jim Simons, which is just fine
by him. Nor are you alone. Many on Wall Street, including
competitors in his specialty, quantitative trading, haven't
heard of Simons or of his operation, Renaissance Technologies
Corp., either. And that's simply extraordinary -- because,
gross or net, Simons may very well be the best money manager on
earth.

An extreme judgment? Perhaps. Certainly, there has been no end
of claimants to the title. And one after another, over the past
few years, these celebrated managers have either blown up or
folded their tents. After big reverses, Julian Robertson closed
down Tiger Management, and George Soros scaled back the
activities of his Quantum Fund this year. John Meriwether's
Long-Term Capital Management nearly took down the financial
world in 1998.

Simons, by contrast, just keeps getting better. Consider his
performance over the past decade. Since its inception in March
1988, Simons' flagship $3.3 billion Medallion fund, has amassed
annual returns of 35.6 percent, compared with 17.9 percent for
the Standard & Poor's 500 index. For the 11 full years
ended December 1999, Medallion's cumulative returns are an
eye-popping 2,478.6 percent (see graph, page 58). Among all
offshore funds over that same period, according to the database
run by veteran hedge fund observer Antoine Bernheim, the
next-best performer was Soros' Quantum Fund, with a 1,710.1
percent return (see table, page 54).

And Bernheim's numbers don't include Medallion's 2000
performance. In a year of exceptional volatility and market
dislocations, the fund is up 64 percent through September. Over
the years, Simons' consistency has been exceptional. Apart from
his second year, 1989, his fund has not had a losing year (it
was down 4.1 percent that year). In fact, in the past decade,
it's never returned less than 21 percent.

"Ten years ago I put a small amount of money into Medallion,"
says one pleased investor, Richard Gelfond, the co-CEO of Imax
Corp., the Canadian giant-screen film company. "Today it's a
big amount of money."

Medallion, which closed to new investors in 1993, is focused
chiefly on commodities and futures trading. Recently, Simons
has expanded his equity business. Last year he launched
Equimetrics, a $500 million U.S. fund with a market-neutral
trading strategy for institutional investors. Despite market
ructions, and the first declining U.S. stock prices in years,
Equimetrics this year has returned 24.1 percent through
September, compared with ­2.23 for the S&P 500 with two
thirds the volatility.

And these are all, it should be noted, net numbers. The price
of Simons' success is high for investors. He charges a
management fee of a stunning 5 percent of assets, in addition
to the normal hedge fund rake-in of 20 percent of
profits.

To be sure, some investors have had even higher returns in
recent years. Hedge fund manager Jeffrey Vinik closed his fund
last month after compiling average annual returns of 53 percent
since November 1996. And Steven Cohen of SAC Capital
Management, reportedly posted returns of 70 percent last year
and 49 percent the previous year. Simons, however, has made
steady profits over 11 years, compared with just seven for
Cohen and four for Vinik.

Simons' risk-adjusted returns are even more impressive. Paul
Wick, manager of Seligman Communications and Information Fund,
leads all U.S. mutual fund managers, according to Morningstar,
with annual returns of 31 percent since 1990. But his Sharpe
ratio over the past three years is 0.42; for the same period,
Legg Mason's celebrated William Miller III boasts average
annual returns of 24 percent -- and a Sharpe ratio of 0.64.
Simons wracked up a ten-year Sharpe ratio of 1.89 throughout
the 1990s, with a 2.52 ratio for the last five years of the
decade. Sharpe ratios are a measure of risk-adjusted returns.
The higher the number, the better.

How does Simons do it? Start with a world-class mathematical
mind. In 1976, at 38, Simons won the American Mathematics
Society's Veblen Prize -- awarded every five years, it is the
geometry world's highest honor -- for his work in the
excruciatingly esoteric field of differential geometry. His
signature work -- a 26-year-old theorem crafted with renowned
geometrician Shiing-Shen Chern that is known as the
Chern-Simons theory -- has recently emerged as a critical tool
for theoretical physicists searching for fundamental laws of
the universe. "Chern-Simons pervades a whole class of theories
that underlie our fundamental view of the observable world,"
says Brandeis University physicist Stanley Deser, an expert on
supergravity, a discipline of quantum theory that studies
elementary particles and their interaction.

"Jim Simons is without question one of the really brilliant
people working in this business," says quantitative trading
star David Shaw, chairman of D.E. Shaw, which boasts returns
above 50 percent this year. "He is a first-rate scholar, with a
genuinely scientific approach to trading. There are very few
people like him."

Simons surrounds himself with like minds. The headquarters of
Renaissance, in the quaint town of East Setauket on New York's
Long Island, resembles nothing so much as a high-powered think
tank or graduate school in math and science. Operating out of a
one-story wood-and-glass compound near SUNY Stony Brook,
Renaissance, founded in 1982, has 140 employees, one third of
whom hold Ph.D.s in hard sciences. Many have studied or taught
in Stony Brook's math department, which Simons chaired from
1968 to 1976. Among their ranks: practitioners in the fields of
astrophysics, number theory, computer science and computational
linguistics. In notably short supply are finance types. Just
two employees, including the head of trading, are Wall Street
veterans.

"I have one guy who has a Ph.D. in finance. We don't hire
people from business schools. We don't hire people from Wall
Street," says Simons. "We hire people who have done good
science."

Confident and witty but intensely secretive about his
business's inner workings, Simons shuns publicity. He agreed to
talk with Institutional Investor only after much pestering (see
box, page 56). And some of what he said was, frankly,
unintelligible. We made the mistake of asking him to explain
Chern-Simons. After half an hour he allowed, "I can't." He
meant, of course, to us.

Simons rarely speaks at financial forums, preferring math
conferences. He celebrated his 60th birthday with a geometry
symposium at Stony Brook that included such lectures as
"Generalized Chern-Simons Invariants as a Generalized
Lagrangian Field Theory." That's one reason he is little known
on Wall Street. Two years ago Renaissance invited Andrew Lo,
whose financial engineering program at the Massachusetts
Institute of Technology is the prime recruiting ground for
quantitative traders, to speak at its headquarters on options
replication. "I had heard of Jim Simons the mathematician, but
I had never heard of Renaissance until they called me up," says
Lo. "I said, 'Jim Simons runs a hedge fund?'"

When he does open up, Simons can seem exasperatingly coy in
describing his success. "Luck," he told a gathering of
potential investors last spring in Greenwich, Connecticut, "is
largely responsible for my reputation for genius. I don't walk
into the office in the morning and say, 'Am I smart today?' I
walk in and wonder, 'Am I lucky today?'"

In fact, Simons is being straightforward. Luck may be the
residue of design to baseball minds, but to a mathematician
it's the twin of probability, which can be approached through
statistical studies. Renaissance's researchers construct
statistical models and proprietary algorithms from exhaustive
scrutiny of market data.

Like all quantitative money managers, Renaissance aims to find
small market anomalies and inefficiencies that can support
profitable trading on billions of dollars of capital. Though
all quant shops are alike in their dedication to models -- Let
the best algorithm win! -- Renaissance's approach differs from
the "convergence trading" popularized by John Meriwether's
Long-Term Capital Management and similar arbitrage shops.
Convergence traders price financial instruments based on
complex mathematical models, find two different instruments
that are cheap and expensive on a relative basis and then buy
one and sell the other, betting that the prices will, at some
point, have to return to their proper level. The Renaissance
approach requires that trades pay off in a limited, specified
time frame. And Renaissance traders never override the
models.

Guided by these models, Medallion's 20 traders conduct
rapid-fire buying and selling of a multitude of U.S. and
overseas futures contracts, including all major physical
commodities, financial instruments and important currencies, in
addition to trading equities and mortgage derivatives. This
year Medallion made a killing in the volatile oil futures
market.

To be sure, Simons' track record is not unblemished. In 1997 he
folded a middling market-neutral fund into Medallion after just
three years. And a mortgage-backed-derivatives fund he backed
in 1995 swooned after enjoying two fine years.

An active venture capitalist and private equity investor in the
U.S. and Latin America, Simons sits on the boards of four
companies, including Franklin Electronic Publishers, the
pioneering electronic spell-checker and book company, of which
he owns 22 percent and is chairman (see box, page 52). Simons
has recently raised a $200 million fund to extend Renaissance's
reach into technology venture capital investments.

Simons' trading record over the past decade is more than luck.
The bigger question is whether he can keep it up. A
chain-smoker in defiance of statistical possibilities, Simons
is 62 and has no designated successor, and the firm is starting
to expand into new areas.

Such a situation can be a recipe for disaster for trading
firms. But Simons says with scientific certainty: "The things
we are doing will not go away. We may have bad years, we may
have a terrible year sometimes. But the principles we've
discovered are valid."

THE SON OF A SHOE FACTORY OWNER, JIM Simons grew up daydreaming
about numbers. "I wanted to do mathematics from the time I was
3," says Simons, who was raised in the Boston suburb of Newton.
"Literally. I would think about numbers and shapes."

After graduating from Newton High School, he entered MIT,
studying under renowned mathematicians Warren Ambrose and I.M.
Singer. (Says Singer: "He's very intuitive. He has a sense of
taste for the right principles in mathematics, and that is very
rare, let me tell you.") He received his BS in math in 1958 at
20 and a mere three years later, a Ph.D. in math from the
University of California at Berkeley. By 23 he was back at MIT
-- on the faculty. After one year, he strolled up Massachusetts
Avenue and spent two more years as a math professor at Harvard
University. There he worked on solutions to such conundrums as
the plateau problem and the Bernstein conjecture, which grapple
with the properties of multidimensional surfaces.

Though a rising star in his field, Simons quickly tired of
academic life. Seeking adventure, he signed on in 1964 as a
code breaker with the Institute for Defense Analyses, a
nonprofit research organization that performed work for the
U.S. Department of Defense. Angered by a New York Times
Magazine story that he thought overly optimistic about the
military effort in Vietnam, Simons made comments to Newsweek
that were critical of the war. After telling his boss about the
interview, he says he was fired from IDA.

Shaken, Simons quickly found a home back in academia. He took
the post of chairman of the Stony Brook math department, where
he would spend the next eight years doing pure research. "I
felt so powerless about being fired," he says. "I thought,
'They can't fire you if you're chairman.'"

Simons' most famous work is his 1974 paper "Characteristic
Forms and Geometric Invariants," which he coauthored with the
renowned Berkeley geometer Chern. It represented an important
breakthrough in geometry that would become known as the
Chern-Simons theory.

Differential geometry, Simons' specialty, is the study of
curved surfaces and spaces. We are all familiar with spheres;
we live on a very big one, after all. But it turns out that,
for mathematicians, they are fiendishly complicated. Geometers
establish the properties that separate one type of object from
another. Although they have been able to determine the
properties of what to laymen are such incomprehensible objects
as spheres with ten dimensions, they have not been able to do
this with spheres in the third dimension. French mathematician
Henri Poincaré postulated at the beginning of this
century that they ought to be able to do so using simple means.
Like Fermat's last theorem, which was finally proved in 1993
after centuries of fruitless efforts, Poincaré's
conjecture is one of the mathematical world's great remaining
mysteries. (The Clay Mathematics Institute has offered a $1
million prize to anyone who can find the solution.)

Chern-Simons was not meant to solve Poincaré's
conjecture, but it does offer calculations that are useful for
distinguishing among shapes in three dimensions. "Chern-Simons
offers a route to solve Poincaré's conjecture," says
Simons, "but it's a difficult route, and there are other
difficult routes."

Difficult, yes, but, say mathematicians, an elegant piece of
abstract reasoning. "Chern-Simons, that's a beautiful thing,"
says George Zettler, a former Columbia University math
professor, who now trades swaps and options for the
mortgage-backed-securities hedge fund Ellington Management
Group. But the paper's language defies translation into plain
English. A random sample: "The Weil homomorphism is a mapping
from the ring of invariant polynomials of the Lie algebra of a
Lie group, G, into the real characteristic cohomology ring of
the base space of a principal G-bundle." Difficult,
indeed.

Chern-Simons has taken on a second intellectual life, because
the theory has come to have a major influence in a completely
different scientific discipline. In the mid-1980s Princeton
University professor Edward Witten, now one of the world's
leading theoretical physicists, noticed the applicability of
Chern-Simons to physics and popularized an area that is loosely
called Chern-Simons quantum field theory. These days
Chern-Simons is used as a tool in many areas of physics
research, from string theory to supergravity to black holes.
"Every day a physicist is working on a new theory with
Chern-Simons," notes Dennis McLaughlin, a
Princeton-mathematician-turned-McKinsey-&-Co.-consultant.

NOT ONE TO REMAIN LOST IN ABSTRACTIONS,
Simons has long had an affinity for business. In 1961, he and a
few MIT classmates invested in a Colombian floor tile and pipe
company. At Berkeley he tried his hand at trading, looking to
invest about $5,000 in wedding gifts from his first marriage.
He found that stocks bored him. "I went to a Merrill Lynch
broker," recalls Simons. "He said, 'Try soybeans.'"

Simons didn't get really hooked on trading until the early
1970s, when he was at Stony Brook. In 1973 the tile company got
sold, and he turned the proceeds over to a mathematician he
knew who was trading commodities. "In eight months he had
multiplied my money by ten times," says Simons.

Even as he was being hailed for his theoretical work, Simons
began to make the transition out of academics, working half
time at Stony Brook and trading currencies with his own money
between 1976 and 1978. In 1978 he left Stony Brook completely,
to form a private investment fund called Limroy. Initially, he
took a fundamental approach, trying to predict factors like
Federal Reserve Board policy and interest rate movements. Over
the next ten years, Limroy grew initial capital 25 times by
investing in everything from venture capital to technical
currency trading.

In 1988 Simons decided to launch a fund that concentrated on
pure trading. He shut Limroy and launched Medallion in March
1988. Concentrating on futures trading, the fund earned 8.8
percent in 1988 but lost money steadily in 1989 until Simons
halted trading in June.

For six months Simons and former Princeton mathematician Henry
Laufer, who is still Renaissance's research chief, rebuilt
Medallion's trading strategy, shifting from fundamental
analysis to the quantitative approach that powers the firm
today. "We started to think about a whole new way to look at
futures," says Simons.

Back in action, Medallion made its mark through rapid,
short-term trading across futures markets. In the early years
the types of inefficiencies that could be exploited by
quantitative trading abounded. The firm made money by simply
arbitraging Treasury bills against Treasury futures contracts.
Luck helped too. In 1990, for example, the fund was long oil
when Iraq invaded Kuwait.

Simons steadily recruited top-tier scientists. They focused on
speeding up systems, studying how to optimize risk allocation
and determining trading strategies. By 1993, after three
dazzling years, Medallion had reached $270 million in assets
and stopped taking new money. And Simons began extending his
reach. By 1994 Renaissance, which had started with 12
employees, had 36 on staff, and Medallion was trading 40 types
of securities, up from 12. Renaissance had always done all of
its trading through outside brokers; the following year it
opened its first in-house trading operation. Today Renaissance
has 140 staffers -- it plans to be up to 150 by year-end -- and
trades 60 different financial instruments around the
clock.

Three years ago Medallion formed an internal fund-of-funds to
invest in outside managers. In part, the fund was looking for
new ways to invest excess capital that investors didn't want
back. Simons also believed the approach would increase
Renaissance's market intelligence and occasionally present
opportunities for Renaissance to acquire another fund.
Medallion now has $500 million invested in 40 outside funds,
including macro manager Louis Bacon's Moore Capital
Management.

Expansion doesn't always work, however. Medallion began trading
mortgage derivatives in its fixed-income portfolio in 1992.
Though not a Renaissance employee, ex­Lehman Brothers
mortgage trader Judah Frankel managed the portfolio for
Medallion. In 1995, following the 1994 bond market rout,
Renaissance decided to make a larger commitment to the mortgage
market and became a co­general partner in a new hedge fund
called Matrix, run by Frankel. After gaining 27.4 percent in
1995, the fund racked up a stellar 101.3 percent return in
1996, according to hedgefundnews.com. Then interest rates moved
out of the range projected for many of Matrix's trades, and the
yield curve inverted. In 1997 the fund gained just 3.3 percent;
then in 1998 it lost 20.6 percent of assets. Though several
Renaissance executives still have money in Matrix, the company
withdrew as a general partner last year. "Inversion was the
kiss of death," says Simons. "The fund was unhedged with
respect to the yield curve."

Renaissance, he says, would not play such a prominent role in
someone else's fund again.

SINCE THE ADVENT OF THE OPTIONS AND
derivatives industry in the early 1980s, Wall Street's banking
houses have fallen over themselves to recruit high-powered
intellectuals from academia. By contrast, Simons has taken his
scientists away from Wall Street, to lavish surroundings in
Long Island, not far from the Stony Brook campus where
Renaissance began life in office space designed to serve as a
business incubator.

Renaissance moved into its East Setauket headquarters three
years ago, but Simons and the firm retain close ties to the
university. Thanks to Simons' generosity, Stony Brook is
considered one of the top ten math departments in the country;
several math professors hold the title of James Simons
Instructor. In addition to having led for more than a decade
the Stony Brook Foundation, which raises and invests a private
endowment for the school, Simons has helped the school take a
lead role in assuming the management of Brookhaven National
Laboratory for the Department of Energy.

Renaissance headquarters feature a gym, lighted tennis courts,
a library with a fireplace and large private offices for every
employee. All back-office and administrative functions are
handled out of the firm's New York offices.

Unusual for a hedge fund, the heart of Renaissance is not its
trading room -- an uncluttered room where a score of traders
buy and sell around the clock -- but rather an auditorium with
exposed beams that seats 100 and features biweekly science
lectures. Last month a molecular biologist presented research
on colon cancer. "When you hear someone talk about an
interesting use of statistics it helps trigger your thinking,"
says one Renaissance employee.

The atmosphere is college casual, if intense -- think of a
perpetual exam week. Though a natty dresser, Simons sets a
properly idiosyncratic tone. "He has been known to show up at
formal business meetings without socks," says Jerome Swartz,
Simons' next-door neighbor on Long Island and an Equimetrics
investor.

Married to his second wife, Marilyn, for about 25 years, Simons
has four children, two of whom are still school age. At
Renaissance he works out of a tidy office with fashionable
leather furniture and a large, somewhat gruesome painting of a
lynx killing a rabbit. "I used to have it in my house," says
Simons. "My wife didn't particularly like it."

Staff turnover is nearly nonexistent. Every six months all
employees receive cash bonuses based on fund performance. The
six-month benchmark is said to be 12 percent -- and it's almost
always easily surpassed. Most employees also hold equity in the
firm. Simons frequently takes the entire staff and their
families -- more than 300 people -- on lavish weekend
vacations. Earlier this year he flew everyone to Bermuda.

Renaissance is divided into three basic groups: computer and
systems specialists, researchers and traders. Once a week
Simons meets with the research group, discussing in detail the
progress of trading strategies under development.

Job candidates don't have to know any finance -- in fact, Wall
Street experience is a black mark -- but they must present a
talk on their scientific research to the entire firm before
being offered a job. Most staffers seem to know little about
the rest of the financial services industry, or even the hedge
fund business. Asked about the performance of legendary futures
trader and Renaissance rival Paul Tudor Jones, one researcher
says, "Who's Tudor Jones?"

For a man who believes in luck, Simons doesn't leave a lot to
chance when it comes to recruiting the staff that builds his
trading models. As the firm's assets grew, Simons recruited
top-flight mathematicians and scientists, including University
of Virginia physics professor Robert Lourie and Bell Labs
numbers theorist Peter Weinberger, to research new trading
strategies. In recent years Simons seems to be especially keen
on stockpiling computational linguists who have worked on
building computers that can recognize speech. He has hired away
a good part of the speech recognition group from IBM
Corp.

Why computational linguists? "Investing and speech recognition
are very similar," says one Renaissance researcher. "In both,
you're trying to guess the next thing that happens."

AS A TRADER, SIMONS TRIES TO OVERCOME
fundamental laws, not discover them. In the case of
quantitative finance, the law is the efficient-markets
hypothesis and the belief that markets should be difficult, but
not impossible, to beat.

In his rare discussions of trading, the Renaissance president
emphasizes that trading opportunities are by their nature small
and fleeting. "Efficient market theory is correct in that there
are no gross inefficiencies," Simons told the Greenwich
Roundtable last year. "But we look at anomalies that may be
small in size and brief in time. We make our forecast. Then,
shortly thereafter, we reevaluate the situation and revise our
forecast and our portfolio. We do this all day long. We're
always in and out and out and in. So we're dependent on
activity to make money."

Renaissance essentially attempts to predict the future movement
of financial instruments, within a specific time frame, using
statistical models. The firm searches for something that might
be producing anomalies in price movements that can be
exploited. At Renaissance they're called "signals." The firm
builds trading models that fit the data.

When the trading starts, the models run the show. Renaissance
has 20 traders who execute at the lowest cost and without
moving markets, crucial requirements for quant investors
trading on narrow margins. But the models decide what to buy
and sell. Only in cases of extreme volatility, or if the
signals appear to be weakening, does the firm sometimes
manually cut back. Says Simons, "We don't override the
models."

Even in structuring its hedge fund-of-funds portfolio,
Medallion takes a quantitative approach. The fund balances the
positions of its outside portfolio to ensure that, overall, the
fund has no stock market exposure; it is, in other words, a
"beta zero" portfolio. Last year the fund-of-funds, on a
risk-adjusted basis, even beat trading returns, posting a
higher Sharpe ratio than the 2.31 recorded for the overall fund
and accounting for about 7 percent of the Medallion's revenues.
Nevertheless, investing with outside managers poses certain
challenges. "We treat these funds as instruments," says Simons.
"But unlike the deutsche mark, managers change their character
over time. It's messier to model those time series, but it's
not impossible. We do our best."

Renaissance has also pioneered advanced trading technologies
that make it possible to earn money on small margins. When few
firms were thinking about electronic trading, a Renaissance
subsidiary quietly installed a direct trading link to the
German futures exchange. "The world is moving in our
direction," says one Renaissance executive. "If the NYSE went
all electronic it would be great for us."

Though Simons won't reveal the specifics of his trading, it's
possible to get a glimpse of Renaissance's style by looking at
Equimetrics, the U.S. market-neutral, long-short portfolio,
started in April 1999 partly to expand Renaissance's base of
institutional investors. Where Renaissance's traditional
strength is rapid trading, Equimetrics hopes to apply the same
principles to low-turnover trading.

Equimetrics was developed by Robert Frey, its CEO, an
eight-year Renaissance veteran who previously worked in the
secretive Morgan Stanley & Co. analytical proprietary
trading group. All trades in the Equimetrics portfolio are made
strictly from proprietary, computer-model-driven strategies,
which pick from a universe of about 1,500 highly liquid common
and preferred stocks. Typically, the portfolio holds about
1,000 positions, with stock index futures used to adjust the
overall risk. No stock is expected to account for more than 5
percent of the portfolio, which will turn over only one to
three times per year. The portfolio's leverage is a modest 2-
or 3-to-1. (At the end of the second quarter, Renaissance held
stock positions of about $2 billion in all its funds, according
to Securities and Exchange Commission filings.)

So far the strategy is working. Last year, in nine months of
trading after the fund's April 1999 launch, Equimetrics gained
12.1 percent, compared with 14.2 percent for the S&P 500.
But this year, with the index down 2.23 percent through
September, the fund was up 24.1 percent; the volatility of the
fund has been just two thirds that of the index.

An Equimetrics report issued to investors in August, shows the
nature of some holdings. As the S&P 500 climbed 6.2 percent
and Nasdaq rose 11.7 percent for the month, Equimetrics was up
4.4 percent, holding a portfolio with its highest sector
weightings in technology (17 percent long, 14 percent short);
industrials (5 percent long, 3 percent short); and energy (9
percent long, 7 percent short). The portfolio's short positions
had a high price-earnings ratio, 26.7, compared with 18.6 on
the long side, and long positions were focused on companies
with much higher average market capitalizations -- $35.8
billion -- compared with an average $19.6 billion for the
shorts.

All sectors had a net exposure of 2 percent or less, except
consumer noncyclicals, which had a ­6 percent exposure. "As
market indices soared this month, the short positions took
losses, but Equimetrics' long portfolio generated strong
returns particularly in technology, financial and energy
stocks," notes the Equimetrics report to investors.

What is not known are the secrets of the algorithms that can
pick stocks smartly enough to beat the market with a portfolio
that's short and long and trade efficiently enough to hold down
costs to a bare minimum. Simons explains his firm's approach as
the financial econometrics equivalent of blocking and tackling.
"We search through historical data looking for anomalous
patterns that we would not expect to occur at random. Our
scheme is to analyze data and markets to test for statistical
significance and consistency over time," says Simons. "Once we
find one, we test it for statistical significance and
consistency over time. After we determine its validity, we ask,
'Does this correspond to some aspect of behavior that seems
reasonable?'"

RENAISSANCE'S RAPID GROWTH, AND ITS continued diversification
into new markets, creates enormous risks for the firm. Even as
it grows its core Medallion business, Renaissance is trying to
master new, difficult areas, from venture capital to
low-turnover trading to investing in outside managers. All have
produced blowups at other successful investment firms; some
rely on talents far afield from Renaissance's scientific
focus.

His firm, insists Simons, remains squarely focused on
scientific finance. "I don't think we would do well getting off
of that stuff," he says.

Simons, however, will no longer be chief scientist. He's
contemplating retirement in three to four years. Going
emeritus, so to speak. He plans to indulge in some "old guy"
stuff like traveling.

And then there's math. Last year Simons and his old college
professor I.M. Singer started fooling around with a fiendishly
involved problem. Both are too busy to plug away consistently,
but when they get together, says Singer, the ideas start
flying.

"It's a fundamental problem concerning the interaction between
math and physics," says Singer. "He could possibly make a very
serious contribution. I have been urging him to come
back."

It's doubtful his investors will be so eager to lose him to the
world of theory. i

The further ventures of Jim Simons

Renaissance Technologies fund whiz James Simons first traded
stocks in the early 1960s, while in graduate school at the
University of California at Berkeley. Soon after, he had tried
his hand at venture capital, when, with some college buddies
from the Massachusetts Institute of Technology, he invested in
a Colombian floor tile and pipe company. That lucrative deal
eventually gave him the capital he used to go into trading full
time in the late 1970s.

Otherwise, though Simons remains an active venture capitalist,
his track record is decidedly more mixed than his stellar
trading history. Still active in Latin America as an investor
in the Sanford Group, the industrial holding company that grew
out of the investments he and his MIT classmates made, Simons
visits the region twice a year.

But technology nowadays plays a prominent part in his U.S.
portfolio. Simons got involved in the early personal computer,
technology-gadgets and electronic-book markets through a 1981
investment in Franklin Computer Corp., which was founded that
year as one of the original general purpose personal computer
companies. But in 1984 the company filed for bankruptcy after
being forced to settle a copyright infringement lawsuit brought
by Apple Computer. It emerged from bankruptcy the following
year under new management.

Through another company, Simons had helped to develop new
technology that would give Franklin a second life. In 1979
Simons and scientist Peter Yianilos, an expert in artificial
intelligence and speech recognition, had founded Proximity
Technology, a pioneer in hand-held electronic book technology
and spell-check software. The technology was futuristic. "The
first book cost $800 to produce," recalls Yianilos.

Franklin bought Proximity in 1988, a year after Proximity had
helped it develop the first blockbuster hand-held computer, a
$69.95 spell-checker called Spelling Ace. Franklin's shares
jumped from from 21/8 to more than 10. In 1990 the company was
renamed Franklin Electronic Publishers. But despite such
product innovations as electronic bibles and wine guides in the
1990s, the company's shares languished, with the exception of a
brief run-up to 44 in 1995 when the company came out with one
of the first electronic books. In October the stock was trading
at 101/4, up from a 52-week low of 33/4.

Through an offshore trust, Simons, now chairman of New York
Stock Exchange­listed Franklin, owns 22 percent of the
company, a stake worth about $16 million. This fall the company
is releasing a new multimedia device called eBookman, which
will allow users to read and listen to books downloaded from
the Internet. "Whether Franklin will someday be a huge success,
I don't know," shrugs Simons.

A bigger score came in the late 1980s, when Simons invested in
Numar Corp., a traditional oil services company, which had
become a leader in applying magnetic resonance imaging
technology to oil and gas exploration. Numar went public at
121/2 per share in April 1994 and was sold in 1997 to energy
services and construction company Halliburton Co. Halliburton
bought Numar for $430 million, making Simons' 900,000 shares of
stock worth about $45 million, four times what they were worth
at the time of the IPO.

Through his partnership in an investment firm called Long
Island Venture Fund, Simons is a major shareholder in a dot-com
direct marketing operation called MyPoints.com, which was taken
public in August 1999 by Robertson Stephens. Simons now has a
chance to feel dot-com pain, with the stock trading at 21/2,
down 97.5 percent from its 52-week high of 9711/16. --
H.L.

The plane truth about trading from Simons

A
theoretical-mathematician-turned-hedge-fund-manager-and-venture-capitalist,Renaissance
Technologies founder and president James Simons has left his
mark on fields ranging from futures trading to electronic books
to theoretical physics. Publicity shy, Simons won't reveal any
of the specific trading strategies that have allowed him to
post one of the great long-term investing records of all times.
But in a recent day of interviews with Senior Editor Hal Lux,
Simons talked about his various academic and professional
lives, what they have in common and what they don't.

Institutional Investor: Do you still do any math
research?

Simons: I think about math, but not with any particular
success. When I left academia, there were still a couple of
problems I was interested in that I'd like to work on when I
retire. About a year ago I started doing some work with a
professor at MIT. I don't know that I have the brains for it
anymore. This work is really different from the deep thinking
you do in math.

Is there a connection between the math you did and your
trading?

None. Absolutely none.

Yet you hire mathematicians and scientists to do much of your
work. Why is that?

Mathematics and science are two different notions, two
different disciplines. By its nature, good mathematics is quite
intuitive. Experimental science doesn't really work that way.
Intuition is important. Making guesses is important. Thinking
about the right experiments is important. But it's a little
more broad and a little less deep. So the mathematics we use
here can be sophisticated. But that's not really the point. We
don't use very, very deep stuff. Certain of our statistical
approaches can be very sophisticated. I'm not suggesting it's
simple. I want a guy who knows enough math so that he can use
those tools effectively but has a curiosity about how things
work and enough imagination and tenacity to dope it out.

Why are the numbers so good this year for your hedge fund,
Medallion?

Once in a while the phenomena we exploit are particularly
present. We like a reasonable amount of volatility. In our
business we want some action.

Yet for many firms the market has proved increasingly
difficult.

Many of the anomalies we initially exploited are intact, though
they have weakened some. What you need to do is pile them up.
You need to build a system that is layered and layered. And
with each new idea, you have to determine, Is this really new,
or is this somehow embedded in what we've done already? So you
use statistical tests to determine that, yes, a new discovery
is really a new discovery. Okay, now how does it fit in? What's
the right weighting to put in? And finally you make an
improvement. Then you layer in another one. And another one.

Are markets more efficient than when you started?

Considerably more efficient. There was a time when we were
trading Treasury bills and we were looking at the discount
structure of the bills. We said, Something is crazy here.
Far-out bills were trading at some huge discount, but the
12-month physical bill was not exhibiting any such discount.
Something was wrong. This was certainly something that a
Long-Term Capital Management would have eliminated in a
microsecond. So we just kept looking at it and saying, Why is
this? The answer was that no one was picking up that
inefficiency. So we bought up a whole bunch of Treasury bill
futures, hedged the position in various ways, kept our fingers
crossed, and sure enough, it came in. It could have gone the
other way, I suppose, but not for very long, because the
chickens had to come home to roost. But those kinds of
opportunities don't exist now. The commodities markets used to
trend pretty heavily -- long-term trends -- but those don't
really exist anymore.

Long-Term Capital Management was, like Renaissance, a
quantitative trading firm. Did you learn any lessons from its
collapse?

Everyone in the company read the book about LTCM. It makes you
wary in a general sense. Our approach is very different. We
don't start with models. We start with data. We don't have any
preconceived notions. We look for things that can be replicated
thousands of times. A trouble with convergence trading is that
you don't have a time scale. You say that eventually things
will come together. Well, when is eventually?

How did LTCM's collapse affect you?

If anything, it was positive. We did very well during that
period. Tumult is usually good for us. We don't have credit
lines of any significance. We don't do a lot of leveraged-type
financing. People were calling us from various banks asking us
about our balance sheets. I had our guys calling our
counterparties: "Tell me about your problems." Generally, those
kinds of times -- and also in '94 -- when everyone is running
around like a chicken with its head cut off, that's pretty good
for us because they seem to evidence the patterns that we know
how to take advantage of.

Is there a size limit for a firm like Renaissance?

There undoubtedly is, but frequently one does not discover that
number until after you're past it. The budget this year is to
end with 150 people. If you were to have asked me five years
ago, "Could you run Renaissance with 150 people efficiently?" I
would have said, "What the hell would they be doing?" That's
why we're on the third expansion of this building. For years
people have asked me, "How much money can you manage?" And my
honest answer has been, "About twice as much as we now manage."
And that's still my answer. We now manage a little less than $4
billion. Can we manage $7 billion or $8 billion? Yes. Could we
manage $70 billion? Of course not. I wouldn't have a clue as to
how to manage that. It's inconceivable to me to manage that
much doing what we do now, but maybe new things would come
along. They always have.

Are you prouder of your mathematical legacy, or of this firm?

I would say about equal. The math stuff I did, the outsize
reputation that some of it received, came well after I stopped
doing it. I wouldn't say that either one is a source of more
satisfaction.

Did you always want to be more than an academic?

In college, while I was busy learning mathematics, it occurred
to me to start a movie theater. There was only the Brattle
Theater in Cambridge. And I thought maybe there's room for
another one. Fortunately, I did not start a movie theater.
There were periods when I would only think about mathematics,
but then I would think, "Gee, maybe there's something else."
Through high school, anything related to business seemed absurd
to me.

Will you retire anytime soon?

To myself, I have said, "I'm 62; by the time I'm 65, I'd like
to pass the baton."

When you retire, will you go back to math?

There are other things I would like to do. I have a charitable
foundation. I'd like to travel. But I expect I would try anyway
and go back and do some mathematics until the point it occurred
to me that this was a waste of my time. I don't know how
quickly that would be. But I'd try, yeah.

Partner Content

An allocation to international bonds exposes Target Retirement Fund investors to an asset class thats not only influenced by different interest rate and inflation dynamics than U.S. bonds, but which also provides a larger opportunity set of credits.